Testing times

Without doubt, bears have raided. We try to fathom what further damage could they cause, for how long and how to cope with it.

The confluence of greed and fear may sound cliched by now, but the Indian stock markets have become prey to the very phenomenon over the past few months.

The Reliance Power public issue is a case in point. Just when it was open for subscription, people from all walks were willing to buy its shares for Rs 450 and were optimistic of their ability to sell them at almost Rs 1,000 upon listing.

Not a shred of the company's fundamentals has altered, but the same market is now pegging its value at around Rs 310 levels now. The intent is not to suggest that the stock is fairly or under-valued at these levels, but the instance reflects the drastic change of market sentiment.

The euphoric one-way upward trek of the BSE Sensex from the 15,000 levels to its peak of 21,207 took more than seven months, while the plunge downward did not even take fifty trading sessions (about two months).

The US-led global credit crunch is finally taking its toll, and every other major bank is dipping into the red. There are signals hinting at a slowdown in earnings, and hence, the risk appetite of investors has nearly vanished.

This has led to a revision in the valuations, so far shaving off anywhere between 25-50 per cent of stock prices that prevailed three months ago. Even then, the fall still persists. Investors are bound to worry about whether there is still more pain left, or the worst is over.

Going by the insight of the experienced, the so-called bear phase may not last as long as the bull-run did, but it will trigger a range-bound phase for a few months, before a reversal of trend.

Besides, the priority now is not to return to the previous peak as much as the reversal of the current down-trend in order to limit the losses.

In India's case, it will also need to prove to the world that its economy is largely decoupled from the global economy with a conviction that India's domestic consumption will continue to drive its growth. Only then, will foreign investors find solace and perhaps, start pouring money to buy Indian stocks.

Uncertainty ahoy
With the wholesale erosion in valuations, investors are facing a dichotomy of attractive buying opportunities against the fear of stock prices falling below these levels. The indecision that crops up makes one question both the macro as well as microeconomic prospects of India.

On the one hand, the economy is likely to continue growing at over 8 per cent while on the other hand, there are fears of a slowdown in corporate earnings, capital expansion plans being postponed, rising cost pressures and risks from foreign exchange exposure of companies.

Putting these factors in perspective, it gets more difficult to figure out the direction that the markets may take over the coming two to four quarters.

Fundamental solace...
In spite of a slowdown in the US, there is little possibility of the Indian economic growth being impacted drastically. First, Indian economy is driven strongly by the domestic consumption boom.

Since a large part of the contribution to the GDP is derived from services, which continues to grow consistently, the overall growth will remain buoyant.

"Even though the short-term outlook may be uncertain, the long-term outlook for India is positive. In FY09, India's economic growth is likely to remain between 8-9 per cent," says Andrew Holland, managing director "" strategic risk group, DSP Merrill Lynch.

... but some worries
On the industry front, mid-sized and small corporates could get impacted. The noise is more than the expected negative impact on account of foreign exchange-based derivatives. Larger companies are likely to have better risk management systems in place.

Besides, smaller and mid-sized businesses are expected to face more difficulty in raising funds for expansion plans, as credit flows may remain limited to larger companies due to a conservative approach and higher risk premiums. The restrictions, imposed earlier, for raising funds via the ECB route has only added to the woes.

"The global financial system is getting risk averse, increasing the cost of credit, which might lead to some slowdown of major capacity expansions that were planned. Robust corporate earnings, witnessed for the last 12 quarters, would get moderated due to rising cost pressure arising out of commodity inputs as well as wage inflation," comments Balasubramaniam A, chief investment officer, Birla Sun Life.

What next?
"We are probably, globally, near the bottom," as Andrew Holland puts it. However, it is still unknown how long the US slowdown will linger on, and thus its impact on the rest of the world, including India.

This leads to an uncertain environment eclipsed by high volatility, as far as the Indian stock market is concerned.

But Abhay Aima, country head, equities and private banking, HDFC Bank, too, has a consoling view: "there may not be a directional correlation with the US economy since a slowdown in the US would mean the need to cut costs, which in turn would mean more outsourcing. So, even if the short term appears shaky, the longer term is good."

Focusing on the direction that the markets could take, Nirmal Jain, chairman and managing director of India Infoline says, "Recovery may start from the month of April with corporate earnings starting to flow in."

Going a step further, Aima suggests that valuations are fair now, and it appears to be a good time to buy. One can expect 12-15 per cent returns over 12 months.

Thus, even though the markets may not have bottomed out yet, there are ample investment avenues for the coming year, till the bulls find their way back to the bourses. Overall, because of the strong domestic growth over a long period to come, the global economic slump is likely to remain just a temporary setback for India.

Pick and choose
Due to the volatility on the streets, stalwarts unanimously recommend a strategy of focusing on asset allocation for realistic returns to investors, rather than trying to time the market.

Advantage India: It is clear by now that those sectors, which derive their growth from the domestic consumption in India are likely to have an upper hand compared to those dependent on exports and global demand.

The likely winners are fast moving consumer goods (FMCG), consumer durables and, multinational pharmaceutical companies, which are expected to introduce newer products in the domestic markets.

For FMCG, while growth prospects continue to be good and valuations reasonable, the budgetary moves will enhance consumption. Higher disposable incomes along with softer interest rates should also benefit the consumer durables sector, which so far has been lagging.

Among others, telecom companies are also expected to witness consistent growth in demand, although valuations may appear slightly rich, which is due to the better visibility of growth in the sector.

Automobiles is another sector that looks good, where valuations have taken a big knock. Notably, most of these sectors carry a far lesser earnings risk, providing cushion during a market downfalls, if things get worse.

Infra plays: Apart from the massive investments (about $500 billion) planned towards creation of new infrastructure during 2007-2012, with the coming year being an election year, greater infrastructure spends are likely, which should prove gainful for the infrastructure-related players, power equipment makers and well-established larger utility companies.

As an economist suggests, given that India's domestic savings rate is high at 32-33 per cent, it's dependence on external funds to finance the infrastructure creation is less""this indicates that such activities are unlikely to witness any slowdown.

Bigger the better: Though an ideal time to get rid of unworthy small- and mid-sized stocks is the peak, it is better late than never.

Apart from unworthy stocks, there will be other vulnerable plays. Investors may want to reshuffle their portfolios to get rid of small- and mid-cap technology companies dependent on discretionary spend from the developed markets, textile companies with high exposure to foreign exchange risks and the stocks from the real-estate space.

Small- and mid-cap stocks are typically more volatile, besides their ability to raise resource (vis-à-vis bigger players) is also less. Hence, these could be avoided""unless one is too confident about the fundamentals and growth prospects of a particular company. Since large-cap stocks tend to bounce back first as the market turns around, a higher exposure to them should help.

Contra bets: The healthcare and information technology (IT) sectors have been major underperformers on the bourses, and for reasons well known.

Within the healthcare space, especially the large domestic multinational drug manufacturers, analysts cite the multi-billion dollar opportunity arising from drugs going off-patent in the US during FY09-FY10.

Given the past track record, the opportunities and low valuations, taking a bet on these should lead to gains. In IT too, valuations are relatively low as compared to a year ago.

Again, experts say that a slowdown in US would require companies to cut costs, which could bring more business for Indian companies, and hence, recommend large IT companies.

Tad riskier: Although there are risks of some impact of the credit crunch and the yet-unknown forex derivatives exposure, valuations appear far more reasonable with regards the banking (specially public sector) and financial services sector. Risk-takers may want to look for the turnaround in sentiments for this sector.

ECONOMIST SPEAK

Shubhada Rao, chief economist, Yes Bank
Indian economy in FY09
While growth drivers remain intact, the uncertainty arising out of global financial markets along with domestic factors like higher inflation and therefore higher interest rates will begin to impact growth.

We expect economy to moderate to about 8.3 per cent growth in FY09. While consumption has remained weak, India's 5-year track record of capital goods expansion reflects strong investment intention.

In recent months however, we do see a marginal moderation in domestic production of capital goods. The weakness in consumer durables is bottoming out and we may expect some revival in consumer durables going forward.

Sujan Hajra, chief economist, Anand Rathi
The math of India's GDP growth
Even though the consensus for FY09 suggests there is a significant slowdown expected in growth, but one cannot be sure of it.

Advance estimates indicate agricultural growth to remain at 2.7 per cent for FY08 and the trend rate is 4 per cent. This creates a base effect. So, in FY09 agricultural growth is highly likely to be at around 5 per cent because of the base effect. In terms of contribution to the overall GDP growth, 85 basis points should come from agriculture in FY09. Even an average monsoon can deliver this.

In services, there has not been much impact and they are still growing close to 11 per cent. Besides, there is no major reason for services to slow down, especially considering that the Sixth Pay Commission is due.

Last time, just the impact of the Pay Commission added 50 basis points from the government sector, so similar impact should also come this time. Services account for 55 per cent of GDP, hence, growth in services should account for 6 per cent GDP growth.

Industry, despite the slowdown, is still growing at 8-9 per cent. Next year, it could grow by 7.5-8 per cent. Since industry accounts for 27 per cent of the GDP it is likely to contribute 1.4 per cent to the overall GDP growth. Summing all this up, a total estimated 8.3-8.5 per cent growth looks pretty likely next year.

The US impact
It is noteworthy that decoupling of India's economic growth with industrial nations has already begun since 1985. India has been growing at a much higher rate than others.

But, there is a direct relation in the direction of growth. There is no denial of the fact that if there is a serious slowdown in industrial nations, then India will be impacted. But, the impact on India will be much less than other emerging markets due to their higher dependence on the US. India is likely to be driven more by the growth in domestic consumption.

Another impact is in terms of capital flows. India is still dependant on foreign funds for growth to some extent as the gap between domestic savings and investments is less than 2 per cent of the GDP. However, most of fund requirement is met through internal savings, which is as high as 34 per cent.

However, the foremost reason that India is less prone to the ill-effects of a global slowdown is that consumption accounts for 67 per cent of the GDP, while investments account for as high as 33 per cent, and a growth of 20 per cent is witnessed here, over the last few years. Therefore, the stimulus to sustain economic growth is available back home, even in the forthcoming years.